Seven years after Manulife pulled off the $15-billion purchase of John Hancock Financial Services Inc., there are calls from Bay Street to do what was once unthinkable: Sell the U.S. business.
That deal, one of the biggest corporate takeovers in Canadian history, made Manulife the fifth-largest life insurer in the world and, for a time, the largest firm by market capitalization on the Toronto Stock Exchange. It single-handedly transformed the company into a global powerhouse, and spurred a bout of nationalistic pride.
But these days, Manulife's U.S. operations are sucking up a large proportion of its resources for little return.
They are responsible for the majority of the troubles that have caused the firm's stock price to sink to less than half its pre-crisis value, and they are expected to be a drag on its earnings for years to come.
When on Monday Standard & Poor's reduced its credit rating on Manulife's key operating subsidiary for the third time in less than two years, it cited as a key factor the U.S. unit, which will be "weaker than historical levels given the current economic environment."
Low interest rates and longer life spans are among the items that are taking a toll of profits and forcing the insurer to re-evaluate its business lines.
Some analysts and investors have recently been pressing the firm to consider more radical steps - selling or spinning off the John Hancock life insurance business.
Right now, it's an unlikely prospect. While Manulife's leaders have weighed all the options, they have no intention of giving up on the U.S. Instead, they've put together a plan that they say should revive the division's growth. It involves intentionally shrinking some parts of the life insurance operations, such as so-called no lapse guarantee universal life policies. Same goes for variable annuities, the products that forced Manulife to raise billions of dollars in capital when stock markets plunged. Prices on these types of products are being raised, and the company expects sales to fall.
In the meantime, Manulife plans to emphasize its U.S. wealth management business, including mutual funds and pension products. As a result, the company expects to earn $1.6-billion in the U.S. in 2015, accounting for the largest chunk of the $4-billion profits it hopes to churn out that year.
The U.S. operations would then have a return on equity of 11 per cent, up from 8 per cent today. They would still be the bedrock of a company that is increasingly looking to Asia for future growth.
"We're very excited about the growth of our U.S. business, particularly in the mutual fund and 401k area," chief executive officer Don Guloien said in an interview last week. "And we will always act in the best interests of shareholders, so no thoughtful idea will not be considered."
One of Manulife's biggest recent headaches in the U.S. stems from its long-term-care business. The company recently asked state regulators to allow it to raise the premiums it charges customers who have already bought the insurance, which is designed to help them pay for nursing home stays or in-house care in their elder years. Those rate hikes, if allowed, would average 40 per cent. Manulife's long-term-care business resulted in a $755-million charge in the latest quarter.
Kathy Kozakiewicz of Phoenix, Ariz., has a long-term-care contract from John Hancock, Manulife's U.S. insurance business. She says she bought it after seeing her father-in-law, who didn't have a long-term-care policy, linger for more than a year with Alzheimer's before getting into a nursing home.
"I watched the family deal with that," she said. "We have two children, and I didn't want them to have to deal with what to do with mom and dad if something should happen. I wanted to have the insurance there to cover it."
Ms. Kozakiewicz, a 59-year-old retired U.S. government employee, bought the policy after John Hancock did a deal with the U.S. Office of Personnel Management to offer the product to federal and postal employees and members of the uniformed services. That deal prevents her rates from rising for now, but she's scared John Hancock will try to increase them in a few years after the contract ends.
"If it's too expensive, you have the choice to stay with it or let it go hoping that you're not going to need it, and then you've wasted possibly 10 years worth of premiums," she said.
John Hancock has stopped selling long-term-care policies to corporations and other groups that want to offer them to their employees.
Manulife needs permission from state regulators to hike prices, a process that is expected to take at least a year. While 40 per cent is the average increase, in some cases it's asking for increases of up to 90 per cent. As an alternative to the price increases, customers could opt to have their benefits reduced: For example, for products that have a 5 per cent annual inflation feature, the customer might elect to have that lowered to 3 per cent.
In addition to the long-term care charge, Manulife also took a $1-billion goodwill hit in the latest quarter because of the diminished prospects for the U.S. economy and its business there.
National Bank Financial analyst Peter Routledge says he thinks that reviving the U.S. division's value "will require bolder action."
"We believe that Manulife should look at transactional options for repositioning its U.S. division," he wrote in a recent note to clients. Part of the reason is a big difference in accounting rules for Canadian life insurers and U.S. ones, which could make Hancock a better fit with a U.S.-based owner, he said. "We note that its insurance businesses may be more attractive to a U.S. GAAP reporting life insurer, than to Manulife, because of the manner in which interest rate reserves are calculated."
(Canadian accounting rules require insurers to assume that the current low interest rates will remain for decades, a scenario that would depress their investment income. As a result, their profits can appear lower than they would under U.S. rules. Capital rules also differ.) Selling some or all of the U.S. insurance businesses could free up capital for better opportunities in Asia, Mr. Routledge wrote. Manulife's U.S. division will continue to require nearly half of the company's equity capital, but produce only one-third of its earnings, he added.
"To alter its economics, Manulife would have to dramatically transform the U.S. segment, which will, by the company's own forecast, remain a major drag on profitability for the next five years."
Citigroup analyst Colin Devine recently downgraded Manulife's stock to a "sell." A large factor behind his decision was what he called "underpriced" products in the U.S., namely living benefit variable annuities, long-term care policies, and secondary guarantee universal life.
"By our tally, each is responsible for losses of at least $1-billion since the start of 2009," he wrote. "While Manulife's financial condition has improved versus a year ago, [the]cost of pricing mistakes at John Hancock will pressure returns for years to come."
Manulife is not alone in having charged too little for a number of products in the U.S. Insurers failed to foresee the impact that volatile stock markets, low interest rates, long life spans and higher health care costs could one day have on their business when they battled for market share a decade ago.
"Management appears to us to still be in denial about Manulife's diminished financial circumstances and the magnitude of the problems it faces, particularly in the U.S.," Mr. Devine wrote.
Mr. Devine suggests that Manulife should dramatically shrink the U.S. trouble-causing businesses, and then sell a non-life insurance business - Manulife Bank in Canada or the reinsurance operations - to raise money.
It's a mistake that could haunt their earnings for decades, Mr. Devine said.
Analysts describe Manulife's turnaround plan as a slow crawl back to health, something that investors who focus on short-term profits might lack the patience for.
"We still have confidence that new CEO Don Guloien can get Manulife turned around but the pace of this and final outcome in terms of return on equity carries considerable risks, in our view."
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Recent failed U.S. Financial Forays...
1. Royal Bank of Canada
Manulife's recent $1-billion reduction in the value of goodwill attached to its U.S. business places it in good company. Canada's largest bank took a $1-billion goodwill charge in 2009 to reflect the shrunken value of its U.S. operations. RBC's former CEO John Cleghorn made the bank's first real foray into U.S. consumer banking about a decade ago with the $2.3-billion (U.S.) purchase of Centura Banks Inc. Despite the fact that the profits were disappointing from the start, it has bulked up with a number of deals since. The U.S. retail bank is now the worst performing part of RBC, and the one that its current management wishes would just go away.
2. Canadian Imperial Bank of Commerce
Investments in products backed by subprime mortgages must have seemed like a good idea at the time. Then the crisis hit and CIBC took more than $10-billion in writedowns and decided maybe not so much. CEO Gerry McCaughey decided to pull the bank out of areas it didn't fully understand, and that included most of its U.S. banking and trading operations, which it sold to Oppenheimer Holdings Inc. for a song.